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Saturday, August 30, 2014

I am very fortunate that most days I work from home. Last year I worked for a large commercial real estate finance company which was my first ever "office" job. The long hours of sitting still were tough for me because I'm someone that generally likes to be moving and talking, but I also knew that it was unhealthy. Fortunately, I got into a rhythm of taking breaks and walking around the pond outside with my co-workers throughout the day, which I believe improved our overall performance. Moving also helps stimulate creativity; see How Taking A 20-Minute Walk Everyday Transformed My Approach To Work.

Friday, August 29, 2014

I try to spend about 50 percent of my time studying the financial markets reading, listening or watching analysts and economists that are bullish. I try to spend the other 50 percent of my time within the bearish camp. I would recommend everyone try do this to avoid confirmation bias; one of the most difficult psychological emotions to avoid while investing.

As markets move through cycles people naturally move, like a force of gravity based on human psychology, toward the side the market is moving. As stocks move up bears cannot withstand it and move into the bullish camp. This happens for natural psychological reasons as I just mentioned but it also happens due to career risk. If a professional in the financial world finds himself away from the crowd, and he is wrong for any period of time, he is terminated (or his fund loses investors). The ocean of financial capital around the world has no patience for under performance for any length of time; especially when the world's most popular index (the S&P 500) is on fire.

Overall throughout my investing lifetime I have enjoyed decent gains in the financial markets by investing in what makes the most sense to me and not what makes the most sense to the crowd. I entered the silver market with tremendous force in late 2005 through late 2007. I bought some at $7 and some at $15, but averaged around $11 through the period. I still hold the position. I felt like a genius at $50 an ounce in April of 2011 for buying and holding, and I feel like an idiot today for not selling at the top because it's back down to $19.50. At these prices I'm once again accumulating the way I was during 2005 and 2007 (Here's why).

One area of the market that I have continued to avoid since late 2010 has been the United States stock market. This was a semi-bad move from late 2010 to 2011 and disastrous move from 2012 to today due to the U.S. market's vertical and explosive tear upward.

Has anything changed? No. I felt the market was overvalued in late 2010 and I feel that it is wildly overvalued today (Here's why). No one cares today about corn, wheat, uranium, or silver (which is great, I hope I can continue to accumulate for a long time), they are only focused on the darling U.S. equity market.

It has become more and more difficult to find bearish views on the market to provide the "50% of my time" study. One of the best writers within the bearish camp is John Hussman. I think he provides a well thought-out argument for why the market should turn down in the (near) future. Like me, he has been (incorrectly) bearish on the U.S. market for years.

When we reach the tail end of a cyclical run the bulls move from patting themselves on the back to an all-out assault on anyone who is betting on a downturn. One of those assaults this week came from John Swedroe of ETF.com who wrote; Why Care About What Hussman Forecasts? He lays out a decimating analysis of Hussman's longer term fund returns (1% return vs. the market average 8% return).

When we reach the end of a market cycle these type of articles make a lot of sense to investors. They are what pushes those that have been on the sidelines (or partially on the sidelines) "all in." Another way to look at it would be to ask; what would the market average returns look like for Hussman's funds vs. the S&P 500 if we were sitting at the peak of the cycle and the market turns lower (Hussman has bets in place that profit or avoid losses in a market decline)?

The efficient market theory enters the lexicon when the market is roaring. "You should always stay with stocks for the long run." "Looking at the long term chart you can see that every dip should always be bought."

What if every dip should not be bought? What if we are sitting at a historical peak in U.S. financial markets; both bonds and stocks? What if the next 20% decline is bought by you, but it is not bought by everyone else, and the market moves another 40% lower? What if it takes 25 years to come back to our current (historically overvalued) peak, the way it did in 1929? Do you have another 25 years to continue buying the dip?

I'm not saying that this will occur or even that it is the most likely event to occur. However, based on current valuations of U.S. stocks and bonds it should certainly be in the realm of possibility (20%?). The following chart comes from Ray Dalio, arguably the most successful hedge fund manager in the world today. His team believes that the expected annual returns moving forward on U.S. stocks and bonds after adjusting for inflation is currently at the lowest point in history (1%):

A 1% return could come in a variety of ways. It could come from a 70% decline followed by large annual gains that average out to a 1% return over the next decade. It could come from the markets moving sideways for 10 years. Either way, doesn't it make you a little nervous that the smartest team of financial analysts in the world are anticipating the worst returns on U.S. assets in history?

I thought John Swedroe's hit piece on John Hussman was actually well written, until I reached the very end and he came over the top with this:

"One reason to do so is that he isn’t telling me, or you, anything that other sophisticated investors (such as pension plans, hedge funds and mutual funds) are unaware of. The market has already priced the risks on which Hussman bases his analysis. He just believes he’s smarter than the collective wisdom of the market. Or, at least, he wants you to believe he is, even if he knows better."

Oh no John, if you could have only stopped before you reached that paragraph. In reality, the market has priced in a world better than absolute perfection moving forward and when the market moves back to reality, I certainly hope Mr. Hussman saves that sentence.

In the meantime, S&P 2000......2500.......3000......Great.

I'll just be buying agriculture, uranium stocks, silver, foreign bonds, Chinese water companies, Russian oil companies and all the other things that the world either hates or does not know exist. I do not manage money so I have no risk of losing "assets under management." I do not work in the financial industry so I have no career risk. I'm just a normal business owner who loves the financial markets.

Hussman and I will check back in with everyone else in a few years to see if sanity has returned. If it hasn't, we'll keep buying the stuff people hate and shorting the stuff people love.

Thursday, August 28, 2014

The video above makes it appear that we are once again back at the point where the U.S. Federal debt is not a problem in the near term (over the decade) but still a problem "sometime in the future."

Their analysis is based on some key assumptions:

1. The economy is out of the woods are there will be no recessions in the future2. Interest rates will not rise3. The demand for U.S. dollars and debt will stay strong forever

Let's review these assumptions one by one:

1. The economy is out of the woods are there will be no recession in the future

We are already over 5 years into the current cyclical recovery. The average recovery throughout history has lasted 39 months or 3.25 years. We are due for a natural turn down immediately, never mind some point far away in the future.

A recession (or relapse into financial panic) would cause the government to "stimulate" with additional deficit spending while tax receipts fall. The result is the return of trillion dollar annual deficits.

2. Interest rates will not rise

We are currently in the final stages of a global bond bubble. Interest rates on government debt are resting at historical lows going back hundreds of years. This record high price for bonds comes at a time when the fundamentals have never been worse. It is not mathematically possible for the U.S. to pay back what it is currently borrowing without severely devaluing the currency it will pay it back with in the future.

Buying a 30 year bond today at these prices is a guaranteed loss of money. So why are investors making these purchases? They are not planning on holding the bonds as a 30 year investment, they are planning on "flipping" the bonds to another investor at a higher price in the short term. The same exact psychology took place with the housing bubble back in 2005. It did not matter if the rent payments covered the monthly mortgage on the home, only that there would be a greater fool to step up and pay a higher price next month.

3. The demand for U.S. dollars and debt will stay strong forever
A few months back China and Russia set up the foundation to begin trading through their own currencies (rubles and yuan) to avoid the use of the U.S. dollar. The foundation began construction this week when Russian oil giant Gazprom Neft announced they would begin selling oil for Rubles/Yuan.

The BRIC nations (Brazil, Russia, India, China) sat down this year to begin building a BRIC central bank that would bypass the use of the (US dominated) IMF. The IMF is currently the world's central bank.

These are tiny snowflakes on a mountainside that appear to be nothing as they fall. They are slowly building up pressure on the mountain and there is an avalanche coming in the future. The coming change does not mean the value of the U.S. dollar will fall to zero, but if 95% of world trade is conducted in U.S. dollars and that number falls to 75%, it is going to have a massive impact on the demand for U.S. dollars worldwide.

Ultimately, a percentage of the trillions of U.S. dollars resting on the balance sheets of central banks around the world as a treasure chest of protection against currency devaluations will no longer be needed. For more on why central banks build these reserves and how it will change in the future I would recommend reading The Dollar Trap, one of the year's best books.

When just a small percentage of those trillions are sent back to the U.S. it will unleash the inflation in America that has been building up for years. The problem exists right now at this moment, not some point "in the future." It is only being masked temporarily by the (false) assumptions above. The best case scenario is for an orderly decline in value for the U.S. dollar, not a rush for the exits.

As a side note to make everything I just discussed discussed even more confusing, I am currently bullish on the U.S. dollar in the short term and recommend holding cash positions in liquid rolling short term treasury bills. I only hold this cash while I wait for sell-offs in foreign currency/bond markets. The goal is to continue to diversify out of U.S. dollars when foreign currencies/bonds go on sale.

Wednesday, August 27, 2014

Does it feel like the U.S. stock market no longer corrects downward? That's because it doesn't. Since we entered QE4 (dotted red line below), the size of stock market corrections have ranged from 4% to 5.4% and they are getting smaller as we go.

Prior to QE4, during the initial stages of the current bear market rally, corrections ranged from 8.5% to 19.7%. People were nervous back then. Now, any concerns about the market turning down have completely disappeared. Any down draft is looked at as an incredible buying opportunity. Any rally is looked at as an incredible buying opportunity. This process occurs during the final stage of a cyclical market rally.

"We should be careful to get out of an experience only the wisdom that is in it and stop there lest we be like the cat that sits down on a hot stove lid. She will never sit down on a hot stove lid again and but she will never sit down on a cold one either."

- Mark Twain

"It's waiting that helps you as an investor, and a lot of people just can't stand to wait."

- Charlie Munger

"Live as if you were to die tomorrow. Learn as if you were to live forever."

- Gandhi

"One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do. I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I wait for a situation that is like the proverbial shooting fish in a barrel."

- Jim Rogers

"Capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich."

- James Grant

"At this juncture, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained."

- Ben Bernanke, March 2007

"Everything that needs to be said has already been said. But since no one was listening, everything must be said again."

- Andre Gide

"When people are getting richer and richer but they're not actually producing anything, it can't end well."

- Louis CK

"In economics things take longer to happen than you think they will, and then they happen faster than you thought they could."

- Rudiger Dornbusch

"I don't write about what I know. I write to find out what I know."

- Patricia Hampl

"Chains of habit are too light to be felt until they are too heavy to be broken."

- Warren Buffett

"Everyone has a plan until they get punched in the mouth."

- Mike Tyson

"Interest on the debt grows without rain."

- Yiddish Proverb

"You can have comfort, or you can have value. You cannot have both."

- Jim Grant

"Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful."

- Warren Buffett

"No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future."

- Ludwig von Mises

"Men who can both be right and sit tight are uncommon."

- Jesse Livermore

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

-Ludwig von Mises

"Most investors think quality, as opposed to price, is the determinant of whether something's risky. But high quality assets can be risky, and low quality assets can be safe. It's just a matter of the price paid for them."

- Howard Marks

"Whenever you find yourself on the side of the majority, it is time to pause and reflect."

-Mark Twain

"None are more hopelessly enslaved than those that falsely believe they are free."

-Goethe

"The longer the markets disobey basic rules of valuation, the bigger the opportunity for good investors to reap the benefits. Value investing works precisely because markets become dysfunctional at times."

-John Coumarianos

Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

-Sir John Templeton

"No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future."

- Ludwig von Mises

"People only accept change in necessity and see necessity only in crisis."

-Jean Monnet

Requiring a central bank to print money to increase government's purchasing power invariably ignites a hyperinflationary firestorm. The result through history has been toppled governments and severe threats to societal stability.

- Alan Greenspan

"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."

- Henry Ford

"Do you want to sell sugared water for the rest of your life? Or do you want to come with me and change the world?"

-Steve Jobs

"I'd be a bum on the street with a tin cup if the markets were always efficient."

-Warren Buffett

"The market can stay irrational longer than the investor can stay solvent."

- Keynes

"While the government struggles to save one crumbling enterprise at the expense of the crumbling of another, it accelerates the process of juggling debts, switching losses, piling loans on loans, mortgaging the future and the future's future. As things grow worse, the government protects itself not by contracting this process, but by expanding it."

-Ayn Rand, 1974

"The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function."

- F. Scott Fitzgerald

"All our life, so far as it has definite form, is but a mass of habits - practical, emotional, and intellectual - systemically organized for our weal or woe, and bearing us irresistibly toward our destiny, whatever the latter may be."

-William James

"Men it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."

-Charles Mackay

The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge.

- Stephen Hawkings

"Give me control of a nations money supply, and I care not who makes it's laws."

- Amschel Rothchild

Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces.

- Sigmund Freud

Many of life's failures are people who did not realize how close they were to success when they gave up.